Sunday, 5 May 2013

Will Egypt go bankrupt?

The Egyptian president,
Mohamed Morsi, has already answered the question in the title by declaring that “Egypt
will never go bankrupt”. But judging by some of the recent headlines, sceptics are still
unconvinced. What does it mean for a country to go bankrupt anyway? And is
Egypt really on the brink of financial collapse?

Rather than using the
poorly-defined term “bankruptcy”, an alternative way for analysing the
financial sustainability of a country is to assess its ability to meet its
external financing needs, which consist of:

·Trade deficit (excess
imports over exports)

·Interest payment on
existing debt

·Paying back external debts
as they fall due

In the short term, external
financing needs can be met by borrowing or drawing from foreign currency
reserves. But no country can borrow forever and reserves will eventually be
exhausted, so the economy must eventually adjust to rebalance external finances.

In an ideal world, the
adjustment is done in a benign manner in which the country gradually winds down
its debt, boosts exports and reduces imports costs. But in times of crisis, a
country may be forced to do the whole adjustment momentarily by defaulting on
debt and instantaneously cutting imports—including food, medicines and energy
needs. This is the dreaded “going bankrupt” scenario. One reason for the
unpopularity of the IMF standard conditions is that the speed of adjustment they
require is too quick for most countries’ liking.

So what are the external
financing needs for Egypt over the next few months? And does it have sufficient
funds to avoid hard-landing?

The IMF currently estimates Egypt’s external financing
needs to be $11.7 billion. This figure can be split into $5 billion of expected
current account deficit (that is trade deficit plus interest payment), and $6.7
billion of maturing external debt over the next 12 months. Raising $11.7 billion
over 12 months may seem formidable, especially without the help of the central
bank’s foreign currency reserves which are near their minimum safety level. But
a more careful look at the numbers suggests it is not so bad.

According to the Central
Bank of Egypt (CBE), of the $6.7 billion of external debt maturing this year, $4
billion are Qatari deposits which are unlikely to be paid back anytime soon. On
top of that, Egypt has recently managed to borrow $2 billion from Libya and an additional $3 billion from Qatar. With a further $1 billion
transfer from Turkey and a potential loan from Russia, the Egyptian government seems
to have secured most of its external financing needs for the next few months as
the table below shows.

Despite its success in
securing loans, the government’s strategy carries some risks. First, it could
unravel if the financing needs increased unexpectedly as a result of energy or
food price shock. A second risk is that of a speculative attack
on the Egyptian pound, especially with the CBE unwilling and unable to fend them off. Third, the over-reliance on Qatari funds to keep the Egyptian
economy on its feet may raise questions about the political price being paid.
Fourth, even if this tactic proves successful, it is at best a short-term fix
rather than a long-term solution.

But the Egyptian government
seems willing to take these risks rather than embarking on the unpopular and
painful economic measures requested by the IMF. Perhaps it is hoping to kick
the can just far enough down the road beyond parliamentary elections.

One of the other forms of financing that seems important in the Egypt situation is the form of indirect financing secured through their energy swap deal. http://www.zawya.com/story/Qatar_to_supply_Egypt_up_to_24_LNG_cargos_in_swap_deal-ZW20130509000104/. By reducing the immediate cost of energy for consumers and energy subsidies for the government (according to the IMF greater than 6% of GDP), it seems like Egypt has gotten a decent short term solution. All at the cost of selling their medium term future to the Qataris. What are your thoughts on this?

Kevin - You are absolutely right. Getting energy supplies from Qatar, Libya and Iraq on favourable prices or credit terms should reduce Egypt's external financing needs below the $11.7bn figure I quoted. I just worry about the medium-term sustainability of all this.

Thank you Ziad for this helpful article. I'm wondering what your opinion is on economics in relation to demographics in Egypt? Perhaps you know of some good material on the topic. I know that in 1900 the population of Egypt was under ten million, and now it is around 80 million. While the country itself is large, most of it is desert and cannot produce wheat or other crops. I recall reading that Egypt imports over half of its wheat. Importing crops is normal, but importing over 50% of the needed wheat? This does not seem sustainable. Anyway, thank you again.

Thank you Abu Daoud for your comment and interesting remarks. I have been (and probably will be for a while) focusing on short-term urgent issues. Demographics are important of course, but their problems are likely to manifest themselves in the medium to long run. That said, I do intend to write about them at some point in the future, so I hope you watch this space.

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About Me (Ziad Daoud)

I am an economist currently based in the Middle East. I have previously worked for an asset management firm and, before that, I did a PhD at the London School of Economics. The views in this blog are solely my own.